Question

On January 1, 2021, Ithaca Corp. purchases Cortland Inc. bonds that have a face value of $240,000. The Cortland bonds have a stated interest rate of 7%. Interest is paid semiannually on June 30 and December 31, and the bonds mature in 10 years. For bonds of similar risk and maturity, the market yield on particular dates is as follows: (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.):

January 1, 2021	9.0	%
June 30, 2021	10.0	%
December 31, 2021	11.0	%

Required:
1. Calculate the price Ithaca would have paid for the Cortland bonds on January 1, 2021 (ignoring brokerage fees), and prepare a journal entry to record the purchase.
2. Prepare all appropriate journal entries related to the bond investment during 2021, assuming Ithaca accounts for the bonds as a held-to-maturity investment. Ithaca calculates interest revenue at the effective interest rate as of the date it purchased the bonds.
3. Prepare all appropriate journal entries related to the bond investment during 2021, assuming that Ithaca chose the fair value option when the bonds were purchased, and that Ithaca determines fair value of the bonds semiannually. Ithaca calculates interest revenue at the effective interest rate as of the date it purchased the bonds.

Answer 1

Solution

Ithaca Corp

1. Calculation of the price Ithaca would have paid for the Cortland bonds on January 1, 2021 (ignoring brokerage fees):

Price of bonds = Present value of bonds + present value of interest payments

Present value of bonds = 240,000 x (P/F, 4.5%, 20)

= 240,000 x 0.4146 = $99,504

Present value of interest payments –

Semi-annual payments = 240,000 x 7% x 6/12 = $8,400

Present value of interest payments = 8,400 x (P/A, 4.5%, 20)

= 8,400 x 13.008 = $109,267

Price of bonds = 99,504 + 109,267 = $208,771

Since the price of bond is lower compared to the face value of bonds, the bond is issued at discount.

Discount on Bonds Payable = 240,000 – 208,771 = $31,229

Entry to record the purchase:

Date	Account Titles and Explanation	Debit	Credit
1-Jan-21	Cash	$208,771
	Discount on Bonds Payable	$31,229
	Bonds Payable	$240,000
	(To record purchase of bonds at discount)

2. Entries related to bond investment during 2021:

Date	Account Titles and Explanation	Debit	Credit
1-Jan-21	Investment in Bonds	$240,000
	Discount on Bonds Investment	$31,229
	Cash		$208,771
	(To record investment in bonds)
30-Jun-21	Cash	$8,400
	Discount on Bonds Investment	$995
	Interest Revenue	$9,395
	(To record fist interest revenue)
31-Dec-21	Cash	$8,400
	Discount on Bonds Investment	$1,040
	Interest Revenue	$9,440
	(To record second interest revenue)

Computations:

June 30, 2021 interest revenue = 208,771 x 4.5% = 9,395

Discount on bonds = 9,395 – 8,400 = 995

Carrying value of bonds = 208,771 + 995 = $209,766

Dec 31, 2021 interest revenue = 209,776 x 4.5% = 9,440

Discount on bonds = 9,440 - 8,400 = 1,040

Carrying value of bonds = 209,766 + 1,040 = $210,806

3. Journal entries (assuming fair value option)

Date	Account Titles and Explanation	Debit	Credit
30-Jun-21	Net unrealized holding gain and loss	$14,629
	Fair-value adjustment	$14,629
	(To record the fair value adjustment)

Computations:

Market yield rate= 10%

Effective rate = 10% x ½ = 5%

Fair value of bonds on June 30, 2021 –

Interest revenue = 240,000 x 3.5% x 12.462 = 104,681

Principal = 240,000 x 0.3769 = 90,456

Fair value of bonds on June 30 = $195,137

Fair value adjustment as of June 30, 2021 –

Initial cost of bonds = 208,771

Increase from discount amortization = 995

Amortized initial cost as on June 30, 20 = 209,766

Less: fair value of bonds on June 30 = 195,137

Fair value adjustment as on June 30 = 14,629

Computations:

Market yield rate = 11% x ½ = 5.5%

Fair value of bonds on Dec 31, 2021 –

Interest revenue = 240,000 x 3.5% x 11.95038 = 100,383

Principal = 240,000 x 0.3427 = 82,248

Fair value of bonds on Dec 31 = $182,631

Fair value adjustment as of Dec31 –

Initial cost of bonds = 208,771

Increase from discount amortization = 995

Value of bonds, june 30 = 209,766

Increase from discount amortization = 1,040

Amortized initial cost as of Dec 31 = 210,806

Less: fair value of bonds as on Dec 31 = 182,631

Fair value adjustments as on Dec 31 = $28,175

4. Journal entries (assuming fair value option)

Date	Account Titles and Explanation	Debit	Credit
31-Dec-21	Net unrealized holding gain and loss	$28,175
	Fair-value adjustment	$28,175
	(To record the fair value adjustment)